The mutual funds were heavily invested in securities backed by subprime mortgages, and the former directors were charged with failing to properly oversee asset valuation. The proceeding, which began in December 2012, alleged that the directors failed to satisfy their pricing responsibilities under the federal securities laws.
“Our settlement sends a clear warning of our commitment to enforce the duty of mutual fund directors and trustees to closely oversee the process of valuing securities held by their funds,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.
Under the securities laws, fund directors are responsible for determining the fair value of portfolio securities for which market quotations are not readily available. Fund directors must determine the methodologies to be used to fair value securities and must periodically reevaluate the appropriateness of those methodologies.
The Commission made clear in Accounting Series Release No. 118 (Dec. 23, 1970) and In the Matter of Seaboard Associates Inc., Investment Company Act Release No. 13890 (April 16, 1984) that while fund directors may engage others to assist them to calculate fair values of these securities, they continue to be ultimately responsible to determine fair value in good faith.
The settled order finds that the eight directors failed to satisfy these responsibilities. The directors delegated their fair valuation responsibility to a valuation committee without providing adequate substantive guidance on how fair valuation determinations should be made.
The directors then made no meaningful effort to learn how fair values were being determined. They received only limited information about the factors involved with the funds’ fair value determinations, and obtained almost no information explaining why particular fair values were assigned to portfolio securities. The limited information provided to the directors was particularly problematic because fair valued securities comprised a significant percentage of the funds’ net asset values (NAVs) – in most cases above 60%.
Reasonable Procedures Were Not Used
The settled order finds that the valuation committee to whom the directors delegated the fair valuation responsibilities did not utilize reasonable procedures and often allowed the portfolio manager to arbitrarily set values. As a result, the settled order finds that the funds overstated the value of their securities as the housing market was on the brink of financial crisis in 2007. The SEC and other regulators previously charged Morgan Keegan and others, and the firms later agreed to pay $200 million to settle charges related to that conduct.
The eight fund directors named are:
- J. Kenneth Alderman, W. Randall Pittman and Mary S. Stone of Birmingham, Alabama
- Jack R. Blair and James Stillman R. McFadden of Germantown, Tennessee
- Albert C. Johnson of Hoover, Alabama
- Allen B. Morgan Jr. and Archie W. Willis III of Memphis
The settled order finds that the directors caused the funds’ violations of Rule 38a-1 under the Investment Company Act of 1940, which requires funds to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws. The directors are also ordered to cease and desist from committing or causing any violations and any future violations of that rule. The directors consented to the entry of the settled order without admitting or denying any of the findings, except as to jurisdiction.